Environmental Impacts of a North
American Free Trade Agreement
and related issues
1.
Why do environmental advocacy groups oppose free trade?
(a). Some have argued that any expansion of workers inevitably leads to more
pollution and faster depletion of natural resources.
(b) Pollution is a severe problem in Mexico and the country's weak regulatory
infrastructure is strained to breaking point. Further industrialization will
exacerbate an already grave problem.
(c) Free trade agreements may undercut regulatory standards in the U.S. Industry
groups will demand less stringent pollution controls — so that environmental
standards will tend toward the lowest common denominator.
(d) As Mexico is not part of Kyoto agreement — energy intensive industries such
as steel, chemicals, aluminum will move to Mexico — or the U.S. will import
these products from Mexican industry. The shift in trade patterns will under mind
Kyoto.
2.
Distinguish between three mechanisms by which a change in trade and foreign
investment can affect the level of pollution and the rate of depletion of environmental resources.
(a) The Scale effect — if trade increases economic activity the level of pollution
will increase.
(b) Compositional Effect: After the expansion of trade will lead each country to
shift resources into the sectors that make more intensive use of it abundant
factors. The net effect on the level of pollution will depend upon whether
pollution intensive activities expand or contract in the country that on average has
the more stringent pollution controls.
(c) Technique effect — Pollution per unit of output might fall in the less
developed country. First foreign producers may transfer modern technologies to
the local economy when restrictions on foreign investment are relaxed. New
technologies are cleaner. Second if income increases the stricter enforcement of
existing laws may be a natural political response to economic growth.
3.
Theory suggests that (1) strict environmental standards weaken a country's competitive
position in pollution-intensive industries and (2) controls cause firms active in the pollution
intensive industry to relocate their activities to less regulated countries.
4.
Empirical work has not supported the theory.
(a) One study tests whether the severity of environmental regulations has altered
the pattern of trade in goods produced by dirty industries. A variable measuring
the stringency of controls fails to contribute to the determination of their net
exports of the five most pollution intensive industries.
(b) Other studies — conclude there is little evidence that pollution abatement
costs have influenced the location decisions of multinationals.
(c) Studies for U.S.-Mexican trade yields mixed results. The import ratio rises
with the share of pollution costs in U.S. industry value added. But the effect is
very small. On the other hand the activities of American owned assembly plants
along the border (maquiladora) is inversely related to the pollution abatement
cost. The cleaner industries are more active in Mexico, perhaps because these are
unskilled intensive goods.
(d) Resource Reallocation: Implications for Policy.
Research has shown that Mexico has a comparative advantage in industries using
large amounts of unskilled labor. These industries are typically not pollution
intensive. The composition effect will stimulate specialization in clear unskilled
— labor intensive industries. The removal by Mexico of barriers to direct foreign
investment can have the opposite effect on international patterns of specialization.
An illustration of how the compositional effect and the scale or investment
effect works against each other is illustrated in the estimated effects of NAFTA
on toxic releases by manufacturing enterprises. For Mexico the estimate of trade
liberalization only (the compositional effect) shows a decrease of - 1,430 for
chemicals and an overall total of -261. But the trade and investment effect (It is
assumed that there is a 10% increase in Mexico's capital stock) shows an increase
of toxic emissions of +4047 for chemicals and +10,466 for the total. In other
words the investment effect swamps the compositional effect.
The authors of the study of NAFTA conclude that:
"Although our estimates in this section must be taken with a large grain
of salt, they suggest conclusions that accord well with intuition. Because Mexico
enjoys comparative advantage in a set of activities (agriculture and laborintensive manufactures) that on the whole are "cleaner" than the average, the
composition effect of trade liberalization may well reduce pollution there. On
the other hand, a NAFTA will cause the United States and Canada to specialize
more in physical and human capital-intensive activities, to the possible (slight)
detriment of their local environments. On the global level, a net benefit may
derive from the movement of the dirtier economic activities to the more highly
regulated production environments."
Also they say that Mexico imports goods whose production requires intensive use
of physical and human capital. The asymmetries in environmental regulations
and enforcement between U.S. and Mexico play, at most, a minor role in guiding
intersectoral resource allocations. A reduction in pollution may well be a side
effect benefit of increased Mexican specialization and trade.
5.
Another author who reviews the empirical evidence on industry location and international
environmental regulations concludes as follows:
Whatever the reason, there remains a large gap between the popular perception
that environmental regulations harm competitiveness and the lack of economic
evidence to support that perception. I suspect that the existing literature cannot
convince policy makers or the public that links between environmental
regulations and industrial location are insignificant, and that the gap between this
literature and the conventional wisdom will continue to foster attempts to
measure those links empirically.
This author reports that:
(i) Between 1988 and 1991 less than 0.5% of the wood-furniture manufacturers in Los
Angeles moved some port of their operations to Mexico.
(ii) A survey of German firms that make investments in developing countries the few
indicate that lax environmental regulations are important and most indicate they are
totally unimportant.
(iii) Another author concentrates on mineral processing and chemical industries. If U.S.
pollution regulations are pushing these industries overseas the following effects should be
discernible in the data (1) polluting sectors will be increasing their foreign direct
investment (FDI) (2) developing countries will be receiving an increasing fraction of FDI
in these industries (3) U.S. imports of these products will be increasing faster than the
imports of other products (4) and increasing fraction of these imports will be coming
from developing countries. The author finds little or no evidence that any of these
changes have taken place.
However, for more disaggregate industry definitions he finds three sets of
industries that have pushed investment overseas (1) manufacturers of toxic, dangerous
product such as asbestos, arsenic trioxide, and some pesticides (2) some metal-processing
industries (3) some organic chemical. These investments are quite small in the overall
scheme of things.
(iv) Two studies of U.S. Mexican trade conclude that if environmental trade effects exist,
they are small.
(v) A World Bank study examines whether developing countries with more open trade
policies attract more pollution intensive industry. They find that contrary to the
expectations of environmentalists the more open economies attract less pollutionintensive industry and that the more closed economies have dirtier industries.
6.
A large number of studies using more disaggregate data study whether firm locational
decisions within the U.S. are sensitive to varying stringency of environmental regulations. These
studies consistently conclude that environmental regulations do not significantly affect site
choice.
7.
Some Reasons for the Absence of Evidence of Industrial Flight.
(i) Environmental regulation costs are a small proportion of total cost there are numerous
other reason — including labor and land costs — taxes, transportation cost proximity to
suppliers which are more important for site location.
(ii) There is plenty of evidence that when multinationals make investments abroad they
use the same clean technology they use at home. It simply does not pay for them to
modify their technologies. Also it is not good public relations or image building for them
to pollute overseas while cleaning up in the U.S.
(iii) Firms may take a long-term view and take into account that in the long run
environmental standard will converge everywhere at a high level. It does not pay to be
"dirty" in the short run and then to have to retrofit or make new investments when
regulations in developing countries are tightened.
(iv) Industries that are heavy polluters maybe oligopolistic and that these firms are not as
sensitive to competitive pressures.
(v) The heavy polluters are not footloose. This point is similar to point (i) such industries
are capital and technology intensive and these considerations dominate environmental
compliance costs.
8.
Relationship between Environmental Degradation and State of Economic Development
Environmentalist are concerned that rapid economic growth in low income countries will
have devastating effects in local, regional and global environments. There is some evidence that
they are correct — the concentration of air pollutants in Chinese and Indian cities are 10 times
higher than in the typical European cities. Though air quality is very poor in Eastern Europe and
Russia and in some special cases such as Athens. Mexico City is very dirty while South Korea
that has gone through rapid development is much cleaner than China though twice as dirty as
Japan.
This suggests that at low level of per-capita income, below $5000, growth income lead to
a deterioration of our quality and probably water quality. But beyond this income threshold
things began to improve. Evidence of this type of relationship — significant deterioration at first
followed by improvements as incomes become low middle, middle, and then rich have been
found for sulfur dioxide, black matter (smoke) and particulates for a cross section of countries at
different levels of income. The explanation for this type of relationship between income and
pollution is as follows: At low levels of income countries don't have the resources, the
technology nor the will to abate — they trade off material improvements at the cost of
environmental degradation. Then as income reaches a certain point the pollution degradation is
so high and incomes sufficient that clean air considerations dominate cost of abatement
considerations. At $5000 of per-capita income countries are more financially capable and have a
technological base to abate more effectively.
In an international economy there is no need for the levels of degradations that have been
observed in China, India and elsewhere over the last 50 to 30 years. The missing element is the
demand for clean air — at that level of income.
So there is a pessimistic side to this story and an optimistic side. Things will deteriorate
and ultimately they will improve. History supports this conclusion. Numerous cities in the U.S.
and Europe had, by present day standards, unacceptable air quality 50 years ago — London,
Pittsburgh, Chicago and numerous other cities were very dirty. In 1965 Chicago was dirty
enough from the fallout of the steel mills that it was necessary to wipe desks in classrooms
before using them and a film of soot covered the windshields of cars every morning.
For years local business and political leaders resisted environmental regulation until a
threshold, economic and political was reached.